Equations “(5)” and “(7) )”. Thus , ku’ ki and kr will fall. Equation “(11)” shows that (Lu
+ Li + Lr ) will rise, given KD . Hence , U must fall to satisfy the Equation “(12)” .
However, the Appendix shows that Lu , Li and Lr may move in any direction .From
Equation “(13a)” we can show that Y will rise if the fall in WrL isless than the rise in
RK ; and this is satisfied if (dwr / dR) < - (K/L ) ; or if kr < (K/L) .Thus, we get the
following proposition:
Proposition : A rise in Pi resulting from subsidization to the informal sector lowers
unemployment; and raises the total factor income if the rural sector is sufficiently
labour-intensive. However, the effect on the informal sector’s employment is
indeterminate.
So, subsidization to the informal sector raises total factor income; and hence national
income may also improve even if the subsidy is financed by taxing the factor income.
Such a strong positive argument for subsidization to the informal sector is not available
in the existing theoretical literature.
4.CONCLUSIONS
The paper has examined the impact of output subsidy given to the informal sector on
urban unemployment, informal sector’s employment and on the domestic factor income
of a small open economy where capital is perfectly mobile among the three sectors. The
simultaneous existence of urban informal sector and urban unemployment has been
explained interms of efficiency wage theory which is applicable to the low wage
informal sector. Informal sector also produces traded goods and the presence of trade
union in the urban formal sector makes the formal wage endogenous.This is highly
observed in many developing countries like India where handloom and handicraft
products are internationally traded and the trade union activities are flashing.
Output subsidy given to the urban informal sector lowers urban unemployment and
raises domestic factor income provided that the rural sector is sufficiently labour
intensive. Its effects on informal sector’s employment is ambiguous.
ENDNOTES
1. Fields(1989) explains this in terms of job searching and Gupta(1993) explains
this in terms of agricultural surplus whose price is fixed.
2. The assumption that the urban informal sector produces internationally traded
good has been found in the models of Grinols(1991),Chandra and Khan(1991)
and Gupta(1997).